Let’s Be Clear: A Transparent Look at Bond Bubble Talk

By Michael Aneiro

Barron’s and this blog have spent some time lately airing opinions about whether bonds are in a bubble. (The latest scorecard: Bill Eigen of JP Morgan Asset Managementsays they are, Fitch Ratings and the Financial Times say they might be, and Jeff Gundlach says they’re not.) This has prompted some readers to chime in that such bubble talk is (naturally) overblown, and that bonds are neither prone to bubbles nor are they in one.

This blog believes a lot of bonds look overvalued right now, particularly given the uncommonly acute downside risks, but that the term “bubble” deserves some special attention, since it can sound unduly alarmist.

By their nature, when it comes to bubble-like overvaluation, stocks are more precarious than bonds. You can lose just about all your money if a stock bubble bursts, but even if bonds in your portfolio default you’ll likely still recover a good chunk of your principal. Rising interest rates, currently the main risk to high-grade corporate bonds, erode bond prices rather than destroying the majority of their face value.

But people don’t buy bonds expecting them to perform just like stocks; they view bonds more defensively. So bond investors, who at this point are accustomed to three decades of falling rates and rising prices, might be in for a shock if their holdings lose value next year, or the year after, or whenever rates commence what most pundits see as an inevitable rise.

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DECEMBER 20, 2012 9:03 A.M.

Anonymous wrote:

No need for a crystal ball, just look at Japan. Huge deficits, economic stagnation, never-ending monetary and fiscal "stimulus", and gradually declining standard of living. Their 10-year yields 0.75%. So will ours.